Stern Advice: A tax strategy for all seasons

May 08, 2013|Reuters

By Linda Stern

WASHINGTON, May 8 (Reuters) - Just when you may have thoughtthat federal tax policy was set - that January's "fiscal cliff"deal meant you could go about your financial life withmulti-year certainty - Washington is again talking ofcomprehensive tax reform.

Both key congressional committee heads - Senate Financechair Max Baucus, a Democrat, and Dave Camp, the Republicanchair of the House Ways and Means Committee - have hinted thatthe impending debt-ceiling increase could be the tree upon whicha new tax code hangs.

The reform they are envisioning would jettison many taxbreaks and use that revenue to lower tax rates. But it's onething to agree on a concept and another to shake hands on all the details. Virtually every line of tax code has its ownconstituency, a fact made evident in a 558-page summary ofopinions on various tax code measures published Monday by theJoint Tax Committee ().

That means the smart money is still betting against personalincome-tax reform. The more Congress talks about it, the morethose constituencies will pony up political contributions, butit's not clear whether anyone except politicians will benefit.

Taxpayers, meanwhile, have to plan their finances so theyare protected under the new rules and under a radically reformedsystem, in the unlikely case one emerges.

Here are some ways to make the most of the income-taxsystem, now and later.

- Max out your tax breaks. In general, a tax deduction isworth more now than later. That is especially true if tax ratesget lowered in the future, even if your specific deduction ispreserved. Direct as much of your money toward those items -health savings account contributions, retirement-plan savings,charitable donations, energy-efficient appliances - that willget you the break. Note that if you earn over $250,000 ($300,000for joint filers), your deductions will be limited, so learn howthey work beforehand.

- Keep your retirement savings tax-diversified. Even if youhave a tax-deferred 401(k) account, put money into a RothIndividual Retirement Account if you qualify. (You have to makeunder $112,000 as a single filer and under $178,000 as a couplefiling jointly to contribute to a Roth.) If you make too much,you can still pay into a traditional but nondeductible IRA andthen transfer the money to a Roth later. That will give you someflexibility to manage your tax hit when you get to thewithdrawal stage of retirement.

- Make a multi-year charitable donation. If you normallygive a set amount of money, consider doubling or tripling itthis year and putting it into a donor-advised charitable fund.That will give you the donation this year but allow you to doleout the money over a few years. You can set up such a fundthrough through one of the major investment companies likeFidelity Investments, Charles Schwab Corp, T. Rowe Price GroupInc or Vanguard. (Most community foundations - nonprofitsdesigned to steer charitable contributions to localorganizations - also will set up personal charitable funds.)

- Be careful about your investments. Several categories ofinvestments have long benefited from special tax breaks. Thatincludes municipal bonds, which pay interest not subject tofederal taxes, life insurance policies and annuities that allowtax deferral until the money in them is used, and goodold-fashioned stocks and other securities that are subject topreferential tax treatment on their gains.

All of those breaks are on the table, though their backershave been able to protect them in one round of tax revisionsafter another. It may make sense to sell winning stocks and takecapital gains when you can, instead of carrying those gains yearafter year - they may be subject to higher tax rates in thefuture. Be more judicious about buying annuities, permanent lifeinsurance policies and other insurance products that charge highfees and might not be good investments without their taxbenefits. That tax deferral could disappear or become worth less(if rates fall), so if you are using insurance as an investment,make sure it performs well and has low fees.

You can stick with muni bonds for now if you are in a hightax bracket and they make sense. But watch Washington carefullyto make sure all the talk doesn't turn into fast tax reformaction. If it does, be prepared to switch out of munis and othertax-protected investments and into other taxable choices.